Americans are still receiving a failing grade at personal finance, according to the latest results from an annual study. And it could not come at a worse time, with the coronavirus pandemic causing massive market volatility, job and income losses compiling at an unprecedented clip, and a level of financial stress for Americans not experienced since 2008.
Just take one question that seems copied out of a maddening college entrance exam math section but can help explain our biggest personal finance weakness.
Can you answer it?
Investment A will deliver a return of either 10% or 6%, with each outcome equally likely. Investment B will deliver a return of either 12% or 4%, with each outcome equally likely. You can expect to earn more by investing in which?
There's only one right answer: It does not matter which investment you choose, because the expected return of each investment is the same, at 8%. If you got it right, that places you in the minority. Only 31% of Americans did in the latest annual financial literacy survey conducted by the TIAA Institute and the George Washington University School of Business Global Financial Literacy Excellence Center (GFLEC).
The concept behind this question — expected return — can lead you into the weeds of corporate finance. But understanding the basic lesson has never been more important: Most Americans are still not very good at comprehending risk. The survey has found this to be Americans' biggest financial blind spot each year it has been conducted since 2017.
"We're not measuring how smart people are. We are not measuring how much people understand math. We want to understand basic concepts that allow us to make good decisions," said Annamaria Lusardi, Denit Trust Chair of Economics and Accountancy at the George Washington University School of Business and a co-author of the study.
"People only think about the stock market, but we face risk in every part of our life: What is the probability a car breaks down? Risk and risk management is not just about investing but unexpected things," said Lusardi, who is a member of the CNBC Invest in You Financial Wellness Council. "We are in the middle of a pandemic now, and we face an even more uncertain future, and here is when knowledge of risk can be particularly important."
Ted Jenkin, CEO and founder of oXYGen Financial, a financial advisory and wealth management firm specializing in Generations X and Y, and a member of the CNBC Financial Advisor Council, said many people do struggle with basic risk concepts. "People can say they will invest more when the market is down 20%, but in real life they don't do it," he said.
"Everyone understands rewards, but hardly anyone understands risk. We should be trying to get back to basic financial literacy about risk and time," Jenkin said. "The stock market is a long-term investment. People without five years or more to be in it shouldn't be in it. There is just not enough education on risk," he said, and that is always compounded after a period of time during which the market seemed to only go up.
Among eight key financial knowledge areas surveyed by TIAA Institute and and GFLEC — which also include earnings, saving, investing, borrowing, consuming and insuring — risk was the one where Americans know the least. "No wonder we're all frantic," Lusardi said.
The survey was conducted among more than 1,000 American adults throughout the month of January. Lusardi said that is key, because the U.S. market was still booming at the time, unemployment was low, and that means more recent events reinforce the importance of the failings exposed in the data. And the question on risk was far from the only one Americans struggled to answer.
On average, adults answered 52% of the survey questions correctly. There was close to a 50/50 split between those who correctly answered over one-half of the index questions (53%) and those who correctly answered one-half or less (47%).
The overall results were up from previous years, and any uptick in personal finance knowledge is positive, Lusardi said, but it has been a small increase.
"This is still a failing grade," Lusardi said. "This is the type of working knowledge we all need to operate. ... We still don't have the knowledge. We still don't have it, even though the crisis was 10 years ago and we have discussed it a lot. The level of financial knowledge is still very low, especially for a country where we are expected to make so many financial decisions, even starting from high school."
Other answers were alarming in terms of the financial fragility exposed by the survey. Thirty-three percent of respondents said they have difficulty making ends meet, while 31% said debt and debt payments prevent them from addressing other financial priorities. And at a moment when a $1,200 government stimulus check may prove insufficient for many struggling Americans, 27% of survey respondents said they could not come up with $2,000 if the need arose within a month.
"This data was when things were going well. That means anyone who loses a job in a month's time could go hungry," Lusardi said.
Borrowing is the financial area in which Americans have the highest level of understanding, which can be of potential help at a time when it is important to look for ways to reduce debt, receive better terms or put off payments. But Lusardi said it is notable for a worrisome reason, too, as knowledge and understanding may emerge from confronting accumulated debt, often from the early stages of adulthood. "We have all gotten used to debt and managing debt and all carry debt, so many forms of it. ... Yes, we know a lot of how to manage debt, because the proportion is quite high."
The survey found that those with less education and lower incomes are more likely to struggle with personal finance on a regular basis.
When asked how much time they spend "thinking about and dealing with issues and problems related to your personal finances," the numbers are much higher among Americans without a college degree. While only 17% of those with a bachelor's degree or higher said they devote more than six hours a week to this, that spikes to 34% among Americans whose highest level of education was high school. Personal finance is still not a mandatory course in many states, and Lusardi said that needs to change when we see numbers like this.
"We are in a very difficult moment, and many don't have the tools to deal with it. We need to think about the future and help people prepare better, not just for a macro shock which no one can face alone of this proportion, but more of the smaller shocks life is full of and that have implications for our society, implications for how resilient it is," Lusardi said. "That resilience comes with better knowledge. We don't need them to be experts. Just the basics are so important."
"We need to get the education going so much earlier, when kids are younger," Jenkin said.
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Lusardi stressed that one should not come away from the data looking to blame individuals. "Individuals are not responsible for a pandemic," she said. What she said the survey does show is that we have not effectively taught and learned lessons of the previous crisis, including the importance of putting resources aside, precautionary savings and managing debt.
Lee Baker, founder, owner and president of Atlanta-based financial planning firm Apex Financial Services, and a member of the CNBC Financial Advisor Council, said it's always best to build up a rainy day fund to cover unexpected risks, and those things happen far too often even though we tend to think they are more likely to happen to other people. As a financial advisor he has many clients who do have emergency funds. For those who do not, now is the time to take a look at conserving cash by reducing expenses and taking advantage of any government or financial institution offers, such as mortgage and debt repayment programs.
But Baker said as an individual who volunteers in the community, he also knows that for many people the idea of "saving a war chest' is not possible. "It's not just a function of financial education or literacy," Baker said. Pointing to the roughly 10 million jobless claims within the past few weeks, he said many of those individuals will be at minimum wages, with most of their income consumed by basic expenses like rent, so the idea of putting money aside for a downturn can be a non-starter.
"When you are at the lower end of the economic spectrum, there is no fat to cut," Baker said. "Inequity is a real thing. We have structural problems."
"Unless there is additional stimulus, the $1,200 has rent covered for one month, or food on the table," Baker added.
Cash-flow management is the big challenge many Americans will be facing now, Jenkin said, a situation that has not been helped in the past decade by the fact that so many people have stopped writing checks. As transactions and recurring payments have all become digital, there has been a lack of transparency on where the money is going every month. His firm, oXYGen Financial, offers a tool for clients to track digital spending, but he said 4 out of 5 do not use it.
"At the middle school and high school level, or even Yale degree, they don't teach you about managing cash flow, and I am concerned about it," he said.
Jenkin recommends a 21-day budget cleanse, especially since most Americans are at home now anyway and it is a good time to take stock of bills and actually read credit card statements. "The majority of clients we deal with don't read their card statement as long as the bill is in between imaginary goal posts; they just pay it," he said.
Three questions every person with the ability to take more control of cash flow should ask now are, Do I need it? Can I afford it? and Can I get a better deal?
"But if you are living in an $800-a-month apartment, you can only cut so much," Jenkin said.
Disclosure: NBCUniversal and Comcast Ventures are investors in Acorns.